Conventional wisdom states that housing expenses should never exceed 28% of a buyer’s total monthly income. Using that figure, if the buyer makes $5,000 per month, that would translate to a monthly housing payment (which should include additional costs like taxes, mortgage insurance, and HOA fees) of $1,400 per month.
To find your client’s amount, the math would look like this:
Your monthly take home pay x 0.28 = Your ideal monthly housing payment
Learn how much house you can afford
Once you have your client’s ideal monthly housing payment in hand, you can use that to find out how much house they can afford. To do this, you’ll also need some additional information. You’ll also need a projected annual interest rate and the number of monthly payments they will make over the life of the loan.
The formula for this is as follows:
Loan amount = (Monthly payment/(Annual interest rate/12) ) x (1 – (1/(annual interest rate/12)*number of monthly loan payments)
The math here can get pretty complicated so we suggest usingthis calculatorto do the legwork instead.
Continuing with the example above, that $1,4000 monthly payment over a 30-year loan with an interest rate of 5% would average out to a loan amount of $260,794.26. For the purposes of this article, I’ll round it to $260,000.
Zero in on your down payment amount
These days, a buyer needs to be prepared to make a down payment of at least 3.5% – 5%. However, if they aim higher and save up a down payment between 10% and 20%, they will have access to better interest rates, which could save them money over the life of the loan.
In addition to paying a higher interest rate, if a client decides to make a lower down payment–say put 3% down on a $400,000 loan ($12,000), rather than 20% ($80,000)–they may have a tougher time finding a loan, have to pay mortgage insurance and other loan fees, and have a higher monthly payment, because lenders consider a lower down payment as a sign of a higher risk.
Fannie Mae and Freddie Mac, the government-sponsored companies that drive the residential mortgage credit market, have 3% down payments on home loans. (See Fannie/Freddie article in this week’s CVAR At A Glance.) Some major commercial lenders are also offering low down payments — and even no down payments — as incentives to spur loan demand.
Buyers who are active or retired service members, or live in a rural area, may have access to zero down payment programs through the Department of Veterans Affairs or the Department of Agriculture’s Rural Development program. It’s always a good idea to ask a lender about down payment options when you’re shopping for a mortgage.
No matter how much a buyer decides to save, the math will look like the following:
Your total loan amount x down payment percentage = down payment amount
In the example above, if I used my $260,000 loan amount and wanted to make a 20% down payment, it would look like:
$260,000 x 0.20 = $52,000
The answer you get is equal to the amount that you should aim to save up to put towards a down payment.
Source: Forbes and NerdWallet